- 1). Inquire about the existing note-payable balance. It is important to know how the existing balance was computed, so any adjustments that may be needed can be classified accordingly. Often, the whole note payment will be erroneously accounted for as a reduction of the note payable, without any interest expense recorded.
- 2). Obtain or re-create the loan amortization schedule. To determine the appropriate amount of interest expense included in the payments, you must determine where the company is on the payment schedule, and the terms of the note. If no amortization schedule can be located, it is reasonable to assume that the amortization schedule began when the asset was originally acquired. However, if monthly payments changed, it may indicate that the note was subsequently refinanced, requiring additional calculations.
- 3). Reclassify payments to interest expense and note-payable principal. To adjust the notes-payable balance to reflect interest expense included in monthly payments, debit the annual amount of interest expense from the amortization schedule, and credit note payable by the same amount. This will record the interest component and increase the note-payable balance to tie in with the amortization schedule.
- 4). Verify that the adjusted trial balance agrees with the amortization schedule. After making the adjusting entries to correct the original accounting treatment, verify that the adjusted trial balance matches the annual interest and note balance on the amortization schedule. If these adjusted balances do not agree, you must review the trial balance, journal entries and amortization schedule to reconcile the accounts.
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